Sowell_Thomas_-_Basic_Economics_-_5th_Edition_2014

legalistic creativity, in order to define various companies as monopolistic or aspotential or “incipient” monopolies. How far this could go was illustrated whenthe Supreme Court in 1962 broke up a merger between two shoe companies thatwould have given the new combined company less than 7 percent of the shoesales in the United States.{256} The court likewise in 1966 broke up a merger of twolocal supermarket chains which, put together, sold less than 8 percent of thegroceries in the Los Angeles area.{257} Similarly arbitrary categorizations ofbusinesses as “monopolies” were imposed in India under the Monopolies andRestrictive Trade Practices Act of 1969, where any enterprises with assets in excessof a given amount (about $27 million) were declared to be monopolies andrestricted from expanding their business.{258} A standard practice in American courts and in the literature on anti-trust lawsis to describe the percentage of sales made by a given company as the share ofthe market which it “controls.” By this standard, such now defunct companies asPan American Airways “controlled” a substantial share of their respective markets,when in fact the passage of time showed that they controlled nothing, or else theywould never have allowed themselves to be forced out of business. The severeshrinkage in size of such former giants as A & P likewise suggests that the rhetoricof “control” bears little relationship to reality. But such rhetoric remains effectivein courts of law and in the court of public opinion. Even in the rare case where a genuine monopoly exists on its own— that is,has not been created or sustained by government policy— the consequences inpractice have tended to be much less dire than in theory. During the decadeswhen the Aluminum Company of America (Alcoa) was the only producer of virginingot aluminum in the United States, its annual profit rate on its investment wasabout 10 percent after taxes. Moreover, the price of aluminum went down overthe years to a fraction of what it had been before Alcoa was formed. Yet Alcoa wasprosecuted under the anti-trust laws and convicted.{259} Why were aluminum prices going down under a monopoly, when in theorythey should have been going up? Despite its “control” of the market for

aluminum, Alcoa was well aware that it could not jack up prices at will, withoutrisking the substitution of other materials— steel, tin, wood, plastics— foraluminum by many users. Technological progress lowered the costs of producingall these materials and economic competition forced the competing firms to lowertheir prices accordingly. This raises a question which applies far beyond the aluminum industry.Percentages of the market “controlled” by this or that company ignore the role ofsubstitutes that may be officially classified as products of other industries, butwhich can nevertheless be used as substitutes by many buyers, if the price of themonopolized product rises significantly. Whether in a monopolized or acompetitive market, a technologically very different product may serve as asubstitute, as television did when it replaced many newspapers as sources ofinformation and entertainment or when “smart phones” that could take picturesprovided devastating competition for the simple, inexpensive cameras that hadlong been profitable for Eastman Kodak. Phones and cameras would be classifiedas being in separate industries when calculating what percentage of the marketwas “controlled” by Kodak, but the economic reality said otherwise. In Spain, when high-speed trains began operating between Madrid andSeville, the division of passenger traffic between rail and air travel went from 33percent rail and 67 percent air to 82 percent rail and 18 percent air.{260} Clearlymany people treated air and rail traffic as substitute ways of traveling betweenthese two cities. No matter how high a percentage of the air traffic betweenMadrid and Seville might be carried (“controlled”) by one airline, and no matterhow high a percentage of the rail traffic might be carried by one railroad, eachwould still face the competition of all air lines and all rail lines operating betweenthese cities. Similarly, in earlier years, ocean liners carried a million passengers across theAtlantic in 1954 while planes carried 600,000. But, eleven years later, the oceanliners were carrying just 650,000 passengers while planes now carried four million. {261} The fact that these were technologically very different things did not mean

that they could not serve as economic substitutes. In twenty-first century LatinAmerica, airlines have even competed successfully with buses. According to theWall Street Journal: The new low-cost carriers in Brazil, Mexico and Colombia are largely avoiding competition with incumbent full-service airlines. Instead, they are stimulating new traffic by adding cheap, no-frills flights to secondary cities that, for many residents, had long required day-long bus rides. Largely as a result, the number of airline passengers in these countries has surged. The newfound mobility has opened up the flow of commerce and drastically cut travel times in areas with poor roads, virtually no rail service and stretches of harsh terrain. {262} One low-cost airline offers flights into Mexico City for “about half the price ofthe 14-hour overnight bus ride.”{263} In Brazil and Colombia it is much the samestory. In both these countries, new low-cost airlines have reduced bus travelsomewhat and greatly increased air travel, as the total number of people travelinghas grown. Planes and buses are obviously very different technologically, but theycan serve the same purpose and compete against each other in the marketplace— a crucial fact overlooked by those who compile data on how large a share ofthe market some company “controls.” Those bringing anti-trust lawsuits generally seek to define the relevantmarket narrowly, so as to produce high percentages of the market “controlled” bythe enterprise being prosecuted. In the famous anti-trust case against Microsoft atthe turn of the century, for example, the market was defined as that for computeroperating systems for stand-alone personal computers using microchips of thekind manufactured by Intel. This left out not only the operating systems runningApple computers but also other operating systems such as those produced by SunMicrosystems for multiple computers or the Linux system for stand-alonecomputers. In its narrowly defined market, Microsoft clearly had a “dominant” share. Theanti-trust lawsuit, however, did not accuse Microsoft of jacking up prices

unconscionably, in the classic manner of monopoly theory. Rather, Microsoft hadadded an Internet browser to its Windows operating system free of charge,undermining rival browser producer Netscape. The existence of all the various sources of potential competition from outsidethe narrowly defined market may well have had something to do with the factthat Microsoft did not raise prices, as it could have gotten away with in the shortrun— but at the cost of jeopardizing its long-run sales and profits, since otheroperating systems could have been substituted for Microsoft’s system, if the pricesof these other operating systems were right. In 2003, the city government ofMunich in fact switched from using Microsoft Windows in its 14,000 computers tousing Linux{264}— one of the systems excluded from the definition of the marketthat Microsoft “controlled,” but which was nevertheless obviously a substitute. In 2013, the Department of Justice filed an anti-trust lawsuit to prevent thebrewers of Budweiser and other beers from buying full ownership of the brewer ofCorona beer. Ownership of all the different brands of beer involved would havegiven the brewers of Budweiser “control” of 46 percent of all beer sales in theUnited States, as “control” is defined in anti-trust rhetoric. In reality, the mergerwould still leave a majority of the beer sold in the country in the hands of otherbrewers, of which more than 400 new brewers were added the previous year,raising the total number of brewers to an all-time high of 2,751. Morefundamentally, defining the relevant market as the beer market ignored the factthat beer was just one alcoholic beverage— and “beer has been losing marketshare on this wider playing field for a decade or more” to other alcoholic drinks,according to the Wall Street Journal.{265} The spread of international free trade means that even a genuine monopolyof a particular product in a particular country may mean little if that same productcan be imported from other countries. If there is only one producer of widgets inBrazil, that producer is not a monopoly in any economically meaningful sense ifthere are a dozen widget manufacturers in neighboring Argentina and hundredsof widget makers in countries around the world. Only if the Brazilian government

prevents widgets from being imported does the lone manufacturer in the countrybecome a monopoly in a sense that would allow higher prices to be charged thanwould be charged in a competitive market. If it seems silly to arbitrarily define a market and “control” of that market by agiven firm’s current sales of domestically produced products, it was not too silly toform the basis of a landmark U.S. Supreme Court decision in 1962, which definedthe market for shoes in terms of “domestic production of nonrubber shoes.” Byeliminating sneakers, deck shoes, and imported shoes of all kinds, this definitionincreased the defined market share of the firms being charged with violating theanti-trust laws— who in this case were convicted. Thus far, whether discussing widgets, shoes, or computer operating systems,we have been considering markets defined by a given product performing a givenfunction. But often the same function can be performed by technologicallydifferent products. Corn and petroleum may not seem to be similar productsbelonging in the same industry but producers of plastics can use the oil fromeither one to manufacture goods made of plastic. When petroleum prices soared in 2004, Cargill Dow’s sales of a resin madefrom corn oil rose 60 percent over the previous year, as plastics manufacturersswitched from the more expensive petroleum oil.{266} Whether or not two thingsare substitutes economically does not depend on whether they look alike or areconventionally defined as being in the same industry. No one considers corn asbeing in the petroleum industry or considers either of these products whencalculating what percentage of the market is “controlled” by a given producer ofthe other product. But that simply highlights the inadequacy of “control” statistics. Even products that have no functional similarity may nevertheless besubstitutes in economic terms. If golf courses were to double their fees, manycasual golfers might play the game less often or give it up entirely, and in eithercase seek recreation by taking more trips or cruises or by pursuing a hobby likephotography or skiing, using money that might otherwise have been used forplaying golf. The fact that these other activities are functionally very different from

golf does not matter. In economic terms, when higher prices for A cause people tobuy more of B, then A and B are substitutes, whether or not they look alike oroperate alike. But laws and government policies seldom look at things this way,especially when defining how much of a given market a given firm “controls.” Domestically, as well as internationally, as the area that can be served bygiven producers expands, the degree of statistical dominance or “control” by localproducers in any given area means less and less. For example, as the number ofnewspapers published in given American communities declined substantiallyafter the middle of the twentieth century, with the rise of television, muchconcern was expressed over the growing share of local markets “controlled” bythe surviving papers. In many communities, only one local newspaper survived,making it a monopoly as defined by the share of the market it “controlled.” Yet thefact that newspapers published elsewhere became available over wider and widerareas made such statistical “control” less and less meaningful economically. For example, someone living in the small community of Palo Alto, California,30 miles south of San Francisco, need not buy a Palo Alto newspaper to find outwhat movies are playing in town, since that information is readily available fromthe San Francisco Chronicle, which is widely sold in Palo Alto, with home deliverybeing easy to arrange. Still less does a Palo Alto resident have to rely on a localpaper for national or international news. Technological advances have enabled the New York Times and the WallStreet Journal to be printed in California as readily as in New York, and at thesame time, so that these became national newspapers, available in communitieslarge and small across America. USA Today achieved the largest circulation in thecountry with no local origin at all, being printed in numerous communities acrossthe country. The net result of such widespread availability of newspapers beyond thelocation of their headquarters has been that many local “monopoly” newspapershad difficulties even surviving financially, in competition with larger regional andnational newspapers, much less making any extra profits associated with

monopoly. Yet anti-trust policies based on market share statistics among locally headquartered newspapers continued to impose restrictions on mergers of local papers, lest such mergers leave the surviving newspapers with too much “control” of their local market. But the market as defined by the location of a newspaper’s headquarters had become largely irrelevant economically. An extreme example of how misleading market share statistics can be was the case of a local movie chain that showed 100 percent of all the first-run movies in Las Vegas. It was prosecuted as a monopoly but, by the time the case reached the 9th Circuit Court of Appeals, another movie chain was showing more first-run movies in Las Vegas than the “monopolist” that was being prosecuted. Fortunately, sanity prevailed in this instance. Judge Alex Kozinski of the 9th Circuit Court of Appeals pointed out that the key to monopoly is not market share— even when it is 100 percent— but the ability to keep others out. A company which cannot keep competitors out is not a monopoly, no matter what percentage of the market it may have at a given moment. That is why the Palo Alto Daily News is not a monopoly in any economically meaningful sense, even though it is the only local daily newspaper published in town. Focusing on market shares at a given moment has also led to a pattern in which the U. S. government has often prosecuted leading firms in an industry just when they were about to lose that leadership. In a world where it is common for particular companies to rise and fall over time, anti-trust lawyers can take years to build a case against a company that is at its peak— and about to head over the hill. A major anti-trust case can take a decade or more to be brought to a final conclusion. Markets often react much more quickly than that against monopolies and cartels, as early twentieth century trusts found when giant retailers like Sears, Montgomery Ward and A & P outflanked them long before the government could make a legal case against them.“Predatory” Pricing

One of the remarkable theories which has become part of the tradition ofanti-trust law is “predatory pricing.” According to this theory, a big company thatis out to eliminate its smaller competitors and take over their share of the marketwill lower its prices to a level that dooms the competitor to unsustainable losses,forcing it out of business when the smaller company’s resources run out. Then,having acquired a monopolistic position, the larger company will raise its prices—not just to the previous level, but to new and higher levels in keeping with its newmonopolistic position. Thus, it recoups its losses and enjoys above-normal profitsthereafter, at the expense of the consumers, according to the theory of predatorypricing. One of the most remarkable things about this theory is that those whoadvocate it seldom even attempt to provide any concrete examples of when thisever actually happened. Perhaps even more remarkable, they have not had to doso, even in courts of law, in anti-trust cases. Nobel Prizewinning economist GaryBecker has said: “I do not know of any documented predatory-pricing case.”{267} Yet both the A & P grocery chain in the 1940s and the Microsoft Corporationin the 1990s were accused of pursuing such a practice in anti-trust cases, butwithout a single example of this process having gone to completion. Instead, theircurrent low prices (in the case of A & P) and the inclusion of a free Internetbrowser in Windows software (in the case of Microsoft) have been interpreted asdirected toward that end— though not with having actually achieved it. Since it is impossible to prove a negative, the accused company cannotdisprove that it was pursuing such a goal, and the issue simply becomes aquestion of whether those who hear the charge choose to believe it. Predatory pricing is more than just a theory without evidence. It is somethingthat makes little or no economic sense. A company that sustains losses by sellingbelow cost to drive out a competitor is following a very risky strategy. The onlything it can be sure of is losing money initially. Whether it will ever recoverenough extra profits to make the gamble pay off in the long run is problematical.Whether it can do so and escape the anti-trust laws as well is even more